Loan-to-value and being underwater
If you owe more than the car is worth, you're underwater. Your down payment and term decide for how long.
Loan-to-value, or LTV, is what you owe divided by what the car is worth. At 100%, the loan and the car are even. Above 100%, you're underwater: if you sold the car, or it was totaled, the money wouldn't cover the loan.
Cars tend to lose value fastest early on, while a loan pays down more slowly at first, because early payments carry more interest. That's how buyers end up underwater on a car they're happy with.
Here's a hypothetical. A $30,000 car, $2,000 in tax and fees, nothing down, financed at 7% for 72 months. You owe $32,000 on day one, an LTV of about 107%. The app assumes a new car loses 20% of its value in year one and 15% a year after that. On that assumption:
- After one year: you owe about $27,550 on a car worth about $24,000
- After three years: you owe about $17,670 on a car worth about $17,340
- After four years: you owe about $12,190 on a car worth about $14,740
That loan stays underwater for just over three years. Put $6,000 down instead and you'd owe $26,000, an LTV of about 87%, and on the same assumption you'd never be underwater.
Being underwater matters most if life changes and you need to sell, or if the car is totaled. A bigger down payment and a shorter term are the two levers that shrink it.
Where it fits in the method
- Stage 2: Lock three squares at home, in order
- Stage 4: Set the numbers before any dealer speaks
- Stage 7: After the lot: a payoff plan
Related in the method
- Get three written offers
- The walk-around appraisal
- Why they go to down payment first
- Bring your own financing
- The walk line